OPEC Supply Risks Skewed to the Upside

Oil prices have cooled off after going on a tear starting at the beginning of August amid a much-needed technical correction and a rethink from traders on supply-demand fundamentals, but markets are still hovering near $50. OPEC’s talk about an agreement on a production freeze in late September has dominated headlines, scaring financial investors with short positions—those betting on lower prices—out of the market and shoring up prices. But perhaps more important than the rhetoric about OPEC members capping production is the possibility of more supply from the cartel returning to the market. During the second quarter, a slew of production outages helped underpin prices and kick the market above $50. Recently, outages in Iraq, Nigeria, and Libya have all garnered a lot of attention since they are partly responsible for pushing fundamentals more toward balance and increased the total outages in the cartel to 3 million barrels per day. However, if supply rebounds steadily in these key producers, where there have been positive developments recently, the global oil market surplus could balloon again.

“Thawing relationships between parties in conflict in areas of disrupted production would be more relevant to the oil rebalancing than an OPEC freeze.”

Leading investment bank Goldman Sachs, in a note released Monday, said the outlook in these three producers is the bigger factor going forward than whether OPEC and non-OPEC countries can agree to capping output in Algiers when an informal meeting will take place on the sidelines of the International Energy Forum. “Thawing relationships between parties in conflict in areas of disrupted production would be more relevant to the oil rebalancing than an OPEC freeze which would leave production at record highs and could prove counter-productive if it supported prices further and incentivized activity elsewhere,” wrote Goldman analysts.

Positive supply developments

The three beleaguered OPEC countries have seen positive signs within the past week or so. Flows from northern fields controlled by Baghdad have resumed on Kurdistan’s pipelines to Ceyhan, while Iraq has also agreed to new contract terms with oil majors to increase its production in the south by as much as 350,000 b/d in 2017. A vessel at the Zueitina port in Libya, recently reopened, started loading crude. In Nigeria, the Niger Delta Avengers, which have knocked production offline, announced a ceasefire agreement.

While the situations in all three countries have improved, they are still precarious, putting supply recoveries in doubt. In Iraq, the tension between Baghdad and the Kurds still looms large, possibly hurting any thaw in tensions between the two. In Libya, where internal strife could hold back progress on increasing exports, local tribes are opposing any increase in production near the Zueitina port. Meanwhile, the Niger Delta Avengers made it clear they could reignite violence at any time.

“Nonetheless, these latest developments are the most tangible since headlines of higher production from these countries started to intensify over the past two months with crude oil physically moving,” said Goldman analysts, who note that the increases could tilt the oil market back into a surplus. Goldman, in previous estimates, had forecast a 230,000 b/d deficit during the second half of 2016.

If the OPEC trio being hampered by outages can increase supply by 500,000 b/d more than expected in 2017, Goldman would slice its price forecast by more than $7 for next year to $45 per barrel.

Goldman emphasized the argument that many analysts have said since the bull market began in early August—talk about a production freeze has been the main impetus behind the rally. “We believe this move has not been driven by incrementally better oil fundamentals, but instead by headlines around a potential output freeze as well as a sharp weakening of the dollar (and exacerbated by a sharp reversal in net speculative positions),” said Goldman analysts.

“This move has not been driven by incrementally better oil fundamentals, but instead by headlines around a potential output freeze as well as a sharp weakening of the dollar.”

A production freeze is possible at the Algiers event, given that there has been a change of leadership in the Kingdom’s energy ministry. But the probability is low, as Russia has said publicly there is no appetite for capping output now. Moreover, the fight between the Saudis and Iran for market share is spurring doubts about any deal, and any price increase from a freeze would undermine the cartel’s long-term aims since a stronger market would improve the outlook for U.S. shale. Goldman also points out the irony of talk of a production freeze being bullish—the group would still be pumping at record levels, a bearish signal. The market may still have a long way to go until it has fully rebalanced and sees a sustained price rally.

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The Fuse is an energy news and analysis site supported by Securing America’s Future Energy. The views expressed here are those of individual contributors and do not necessarily represent the views of the organization.

Issues in Focus

Safety Standards for Crude-By-Rail Shipments

A series of accidents in North America in recent years have raised concerns regarding rail shipments of crude oil. Fatal accidents in Lynchburg, Virginia, Lac-Megantic, Quebec, Fayette County, West Virginia, and (most recently) Culbertson, Montana have prompted public outcry and regulatory scrutiny.

2014 saw an all-time record of 144 oil train incidents in the U.S.—up from just one in 2009—causing a total of more than $7 million in damage.

The spate of crude-by-rail accidents has emerged from the confluence of three factors. First is the massive increase in oil movements by rail, which has increased more than three-fold since 2010. Second is the inadequate safety features of DOT-111 cars, particularly those constructed prior to 2011, which account for roughly 70 percent of tank cars on U.S. railroads. Third is the high volatility of oil produced from the Bakken and other shale formations, which makes this crude more prone towards combustion.

Of these three, rail car safety standards is the factor over which regulators can exert the most control. After months of regulatory review, on May 1, 2015, the White House and the Department of Transportation unveiled the new safety standards. The announcement also coincided with new tank car standards in Canada—a critical move, since many crude by rail shipments cross the U.S.-Canadian border. In the words DOT, the new rule:

Since the rule was announced, Republicans in Congress sought to roll back the provision calling for an advanced breaking system, following concerns from the rail industry that such an upgrade would be unnecessary and could cost billions of dollars. The advanced braking systems are required to be in place by 2021.

Democrats in Congress have argued that the new rules are insufficient to mitigate the danger. Senator Maria Cantwell (D-WA) and Senator Tammy Baldwin (D-WI) both issued statements arguing that the rules were insufficient and the timelines for safety improvements were too long.

The current industry standard car, the CPC-1232, came into usage in October 2011. These cars have half inch thick shells (marginally thicker than the DOT-111 7/16 inch shells) and advanced valves that are more resilient in the event of an accident. However, these newer cars were involved in the derailments and explosions in Virginia and West Virginia within the past year, raising questions about the validity of replacing only the DOT-111s manufactured before 2011.

Before the rule was finalized, early reports indicated that the rule submitted to the White House by the Department of Transportation has proposed a two-stage phase-out of the current fleet of railcars, focusing first on the pre-2011 cars, then the current standard CPC-1232 cars. In the final rule, DOT mandated a more aggressive timeline for retrofitting the CPC-1232 cars, imposing a deadline of April 1, 2020 for non-jacketed cars.

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DataSpotlight

The recent oil production boom in the United States, while astounding, has created a misleading narrative that the United States is no longer dependent on oil imports. Reports of surging domestic production, calls for relaxation of the crude oil export ban, labels of “Saudi America,” and the recent collapse in oil prices have created a perception that the United States has more oil than it knows what to do with.

This view is misguided. While some forecasts project that the United States could become a self-sufficient oil producer within the next decade, this remains a distant prospect. According to the April 2015 Short Term Energy Outlook, total U.S. crude oil production averaged an estimated 9.3 million barrels per day in March, while total oil demand in the country is over 19 million barrels per day.

This graphic helps illustrate the regional variations in crude oil supply and demand. North America, Europe, and Asia all run significant production deficits, with the Middle East, Africa, Latin America, and Former Soviet Union are global engines of crude oil supply.